Our Greedy Colleges 2.0

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Twenty-five years ago this past Saturday, then-Secretary of Education William J. Bennett argued in a New York Times essay called "Our Greedy Colleges" that “increases in financial aid in recent years have enabled colleges and universities blithely to raise their tuitions, confident that federal loan subsidies would help cushion the increase.” Ever since, the notion that colleges raise tuition to capture financial aid has gone by the moniker of the Bennett Hypothesis.

Scholars have tested the Bennett Hypothesis for two and half decades and the result is a mountain of evidence that neither rejects nor confirms the notion. While no study has found that a $1 increase in aid leads to a $1 increase in tuition, a significant number of studies find that the effect on tuition is not $0, meaning that the tendency of many within higher education to label the Bennett Hypothesis a myth is not justified.

Given the ambiguous evidence, it is clear that the theory needs revision. And indeed, a few refinements go a long way toward reconciling the theory’s predictions with the empirical data, indicating that the original theory was oversimplified.

The first refinement accounts for the fact that aid directed toward low-income students (such as Pell Grants) is much less likely to lead to higher tuition than is aid directed at relatively rich students (such as the higher education tax credits). Aid restricted to low-income families allows students who were previously priced out of higher education to attend, without giving colleges the ability to raise tuition without again pricing these students out of higher education. That is not the case with aid given to relatively affluent students who will attend college regardless of price.

The second refinement is to note that many public colleges are subject to explicit or implicit caps on tuition by their state legislatures, and that many private colleges are trying to become more selective to move up in college rankings. This means that rather than raise tuition as much as possible when aid is increased, many colleges will instead grow their applicant pool, allowing them to become more selective.

The third refinement introduces Bowen’s Rule, which refers to the tendency for colleges to raise and spend all the money they can in the pursuit of excellence. This sounds innocent enough, but the implication is that costs will rise whenever revenue rises. Because increases in financial aid give colleges the option to increase revenue, financial aid is partly responsible for the surge in spending by colleges.

This new and improved Bennett Hypothesis 2.0 is more reassuring than the original about the ability of financial aid to improve college affordability in the short term. Targeting aid to low-income students, placing caps on tuition increases at public institutions, and even negative publicity for colleges that raise tuition too much can all help restrain tuition increases.

But Bennett Hypothesis 2.0 tells a more depressing story in the long run. Because competition among colleges is based on their relative standing, those colleges that exploit the opportunity to raise tuition when financial aid is increased will be able to improve relative to those that do not by hiring better professors, offering more aid to attract meritorious students, building state-of-the-art laboratories, etc. To avoid falling behind, even those colleges that initially resisted are forced to follow suit and raise tuition.

The key lesson is that we need to be very careful when (re)designing financial aid programs to avoid the very real danger that financial aid money will be captured by colleges without improving college affordability.